British pound swings cause uncertainty for business

The British pound is getting caught between the dollar's surge and the euro's slump, and its swings are shaking things up for business just as uncertainty grows over a potentially tight general election.

Caught in the crossfire of developments in the United States and the 19-country Eurozone, the pound has dropped to a five-year low against the dollar but pushed to a seven-year high against the euro.

Against the dollar, it is trading below US$1.50, its lowest since 2010, largely due to expectations that the Federal Reserve will start raising interest rates this year. Higher rates tend to bolster a currency's value.

At the same time, the pound has perked up against the euro amid concerns over the Eurozone economy that prompted the European Central Bank to launch a €1.1-trillion government bond-buying stimulus programme. The pound this month rose above €1.40 to the highest level against the euro since the end of 2007.

For British consumers, the impact is straightforward: it will make summer holidays in the eurozone, such as the beaches of Greece and Spain, cheaper than before. At the same time, it will make any shopping spree on Fifth Avenue more expensive.

On the whole, the British stand to gain as they travel more to Europe than they do to the United States.

The pound's gyrations may also help households by delaying the moment United Kingdom borrowing rates start rising.

Because most British imports originate from the Eurozone, the pound's rise against the euro means inflation will be lower than expected. Figures Tuesday showed inflation at zero in February for the first time on record, raising the spectre of deflation, a prolonged period of falling prices that can choke an economy.

Though few economists think a cut is likely, the fall in inflation has eased expectations that UK borrowing rates will rise this year, to the relief of mortgage holders as well as businesses.

HEADWINDS AND HEADACHES

Beyond the potential for lower interest rates, the pound's movements are complicating life for British businesses.

In theory, British exporters stand to gain in the US where their goods will be relatively cheaper for consumers. Conversely, the same exports will become relatively more expensive in the Eurozone.

The net effect is not even, though. Britain's trade with the US is dwarfed by that with the Eurozone. In 2014, the US was Britain's single biggest export market at 12.7 per cent. However, that was way short of the Eurozone's collective total of around 45 per cent.

So the economic pain of the pound's appreciation against the euro is set to more than offset any of the gains made in the US.

On top of that, the pound's fall against the dollar is likely to make companies' production costs rise since the dollar is used to price most commodities essential raw materials like oil and copper. The pound's weakness, for example, means fuel prices are higher than they otherwise would be.

The situation is "generally an unappetising and unfortunate mix" for British companies, says Howard Archer, chief European economist at IHS Global Insight.

Though the pound has been buffeted by developments outside its borders, its future performance could hinge on domestic matters.

The general election on May 7 is expected to be tight. Opinion polls show the Conservative Party, the main party in the current coalition government, is neck-and-neck with the main opposition Labour Party. Because no party is expected to achieve a majority, deals with smaller parties will likely be needed to form a government.

One scenario that could prompt volatility is the prospect of a referendum on Britain's membership in the European Union. The Conservatives have said they will hold one in 2017 if they form a government after the election. The small UK Independence Party may demand an earlier one if they end up propping up the Conservatives.

With many potential permutations, the uncertainty over Britain's economic course could cause further volatility in the pound, and headaches for business.

"Political uncertainty is likely to continue to build in the coming weeks as the election campaign gets into overdrive," said Kathleen Brooks, research director at Forex.com.